UAE inflation may rise to 12pc in 2008
Inflation in the UAE is expected to soar to a record 12 per cent this year unless immediate steps are taken to revalue the dirham to tighten monetary policy, warned a leading global financial management and advisory company.
Predicting that strong capital inflows, extra-loose monetary policy, weakening fiscal prudence and imported inflation are likely to drive inflation in the absence of a tight monetary policy. Merrill Lynch also said currency strengthening should be used as a policy tool in the fight against inflation.
"Therefore de-pegging and/or revaluation of the currencies will remain under the spotlight in 2008 in the UAE and other GCC countries. The UAE and Qatar, both recording double-digit inflation rates and broad-based strong GDP growth, are on our watch-list as we expect the two GCC countries to be the first to revalue and re/de-peg from a tumbling dollar."
Consumer Price Index (CPI) inflation in the UAE, one of the highest in the GCC after Qatar, has been on an upward spiral, reaching 9.2 per cent in 2006, and an estimated 10 per cent in 2007 and 12 per cent in 2008.
In its latest research analysis, Merrill Lynch noted that under the currency pegs, GCC monetary policy mimics the Fed Funds rate. "However, Fed policies in dealing with a US recession are not going down well in the GCC, whose members are aiming to curb inflation. With the Fed making further cuts and the GCC countries following suit, real rates in the region are likely to slip further into negative territory, thereby further fuelling fire."
The report warned that with an 80 per cent expatriate population and mega investment projects, rising living/building costs threaten the sustainability of UAE's growth model and need to be addressed.
"There are many reasons for high inflation in the UAE, but the currency peg to the dollar lies at the heart of problem. The domestic economy, especially the non-oil sector, is already heated up, hitting supply-side constraints," the report said.
According to Turker Hamzaoglu, financial investment strategist at Merrill Lynch, with heated domestic demand in the region, pegs to the sliding dollar not only import inflation and fuel domestic liquidity but, more importantly, they also import easing monetary policy as the Fed cuts rates and GCC countries follow suit.
"This pushes inflation further. Inflation is likely to stay on an increasing trend in the short-term."
GCC countries have built up a cumulative current account surplus of some $730 billion over the past five years. Capital inflows have gained pace, and the region is awash with cash. Big investment projects are kick starting one after another. Some supply-side bottlenecks seem inevitable in the short term, particularly in the housing sector in the UAE and Qatar.
Inflation in the GCC, the report said, increased from 0.3 per cent in 2001 to an estimated 6.3 per cent in 2007, ranging widely from three per cent in Bahrain to 14 per cent in Qatar. "The common trait for all six countries is the fact that inflation is on the rise. While there is a wide consensus that higher inflation is a side-effect of the GCC's rapid and oil-driven economic boom, views differ widely as to pinpointing the source of the region's rising inflation."
Calling for de-pegging and/or revaluation to ease inflationary pressure, Merrill Lynch said the positive terms of trade shock brought about by the oil bonanza are the main drivers of GCC inflation.
"Without the peg, such terms of trade shock would have led to currency appreciation, helping to mop up excess liquidity, making home goods less attractive and easing imported inflation. However, as governments have been reluctant to revalue and/or de-peg, real adjustment is taking place via higher inflation." Source
Predicting that strong capital inflows, extra-loose monetary policy, weakening fiscal prudence and imported inflation are likely to drive inflation in the absence of a tight monetary policy. Merrill Lynch also said currency strengthening should be used as a policy tool in the fight against inflation.
"Therefore de-pegging and/or revaluation of the currencies will remain under the spotlight in 2008 in the UAE and other GCC countries. The UAE and Qatar, both recording double-digit inflation rates and broad-based strong GDP growth, are on our watch-list as we expect the two GCC countries to be the first to revalue and re/de-peg from a tumbling dollar."
Consumer Price Index (CPI) inflation in the UAE, one of the highest in the GCC after Qatar, has been on an upward spiral, reaching 9.2 per cent in 2006, and an estimated 10 per cent in 2007 and 12 per cent in 2008.
In its latest research analysis, Merrill Lynch noted that under the currency pegs, GCC monetary policy mimics the Fed Funds rate. "However, Fed policies in dealing with a US recession are not going down well in the GCC, whose members are aiming to curb inflation. With the Fed making further cuts and the GCC countries following suit, real rates in the region are likely to slip further into negative territory, thereby further fuelling fire."
The report warned that with an 80 per cent expatriate population and mega investment projects, rising living/building costs threaten the sustainability of UAE's growth model and need to be addressed.
"There are many reasons for high inflation in the UAE, but the currency peg to the dollar lies at the heart of problem. The domestic economy, especially the non-oil sector, is already heated up, hitting supply-side constraints," the report said.
According to Turker Hamzaoglu, financial investment strategist at Merrill Lynch, with heated domestic demand in the region, pegs to the sliding dollar not only import inflation and fuel domestic liquidity but, more importantly, they also import easing monetary policy as the Fed cuts rates and GCC countries follow suit.
"This pushes inflation further. Inflation is likely to stay on an increasing trend in the short-term."
GCC countries have built up a cumulative current account surplus of some $730 billion over the past five years. Capital inflows have gained pace, and the region is awash with cash. Big investment projects are kick starting one after another. Some supply-side bottlenecks seem inevitable in the short term, particularly in the housing sector in the UAE and Qatar.
Inflation in the GCC, the report said, increased from 0.3 per cent in 2001 to an estimated 6.3 per cent in 2007, ranging widely from three per cent in Bahrain to 14 per cent in Qatar. "The common trait for all six countries is the fact that inflation is on the rise. While there is a wide consensus that higher inflation is a side-effect of the GCC's rapid and oil-driven economic boom, views differ widely as to pinpointing the source of the region's rising inflation."
Calling for de-pegging and/or revaluation to ease inflationary pressure, Merrill Lynch said the positive terms of trade shock brought about by the oil bonanza are the main drivers of GCC inflation.
"Without the peg, such terms of trade shock would have led to currency appreciation, helping to mop up excess liquidity, making home goods less attractive and easing imported inflation. However, as governments have been reluctant to revalue and/or de-peg, real adjustment is taking place via higher inflation." Source
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